Chen v. Howard-Anderson: Court of Chancery Distinguishes Lyondell and Explains Application of Exculpatory Provisions in Change of Control Cases
June 12, 2014
In Chen v. Howard-Anderson, C.A. No. 5878-VCL, 87 A.3d 648 (Del. Ch. 2014), the Court of Chancery, by Vice Chancellor Laster, ruling on a motion for summary judgment, held that, in a change of control case where the standard of review is enhanced scrutiny, directors and officers could be found liable for acting in bad faith (and thus breach their fiduciary duty of loyalty) if plaintiffs cite evidence sufficient to support an inference that the directors and officers acted unreasonably in conducting the sale process and allowed interests other than the pursuit of obtaining the best price reasonably available to influence their actions. In so holding, the Court distinguished the Delaware Supreme Court’s decision in Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009).
Viewing the facts in the light most favorable to plaintiffs for purposes of defendants’ motion for summary judgment, the Court found that the record supported the inference that the directors and officers of Occam Networks, Inc. (“Occam”) acted unreasonably in conducting the sale of Occam to Calix, Inc. (“Calix”). The Court next considered defendants’ argument that, under Lyondell, the directors were nonetheless protected from liability by the corporation’s exculpatory provision unless plaintiffs could show that the directors had acted in bad faith by “knowingly and completely failing to undertake their responsibilities.” The Court rejected this argument. The Court explained that the Lyondell decision addressed a situation in which plaintiffs sought to show bad faith by alleging that the directors had consciously disregarded known duties to act. However, this was not the only theory that a plaintiff could assert in an effort to show bad faith conduct outside the scope of an exculpatory provision. In particular, the Court of Chancery noted that plaintiffs may attempt to establish bad faith conduct by asserting that the directors were influenced by interests other than obtaining the highest price reasonably available for the stockholders. The Court found that the Lyondell decision did not address, and therefore was inapplicable to, situations in which plaintiffs attempted to make the bad faith showing through such allegations.
Turning to the evidence presented by the Chen plaintiffs, the Court concluded that the evidence was insufficient to support an inference that the outside director defendants acted in bad faith by allowing interests other than the pursuit of obtaining the best price reasonably available to influence their decisions. Accordingly, the Court granted summary judgment with regard to the process-based claims in favor of the outside directors. The Court, however, found that the evidence was sufficient to support such an inference against the officers of Occam. The Court further noted that Section 102(b)(7) of the Delaware General Corporation Law does not authorize exculpation of officers. Therefore, the Court declined to grant summary judgment with regard to the claims against the Occam officers.
Occam was a publicly traded Delaware corporation that developed, marketed and supported products for the broadband access market. From early 2009 to mid-2010, Occam, with the assistance of its financial advisor, Jefferies & Company, Inc. (“Jefferies”), engaged in a series of discussions with two broadband access companies, Calix and Adtran, Inc. (“Adtran”), regarding a potential sale of Occam, and also engaged in discussions with a third broadband access company, Keymile International GmbH (“Keymile”), regarding an acquisition of Keymile by Occam as part of a “standalone” alternative to a sales transaction. By June 2010, Occam had submitted a proposal to purchase Keymile for approximately $80 million, Calix had submitted three proposals to acquire Occam (the latest of which had an offer price of $7.72 per share to be paid in a mix of cash and stock), and Adtran had sent Occam a letter of intent proposing an all-cash offer for Occam at a price of $8.60 per share, representing a premium of approximately 11% over Calix’s latest offer. After meeting to consider the three alternatives on June 30, 2010, the board of directors of Occam (the “Board”) directed management and Jefferies to give Adtran a 24-hour deadline to submit a revised bid and instructed Jefferies to conduct a 24-hour market check to determine whether any other third parties might be interested in a transaction with Occam.
Neither Adtran nor any of the third parties contacted by Jefferies submitted a revised proposal to acquire Occam by the deadline set by the Board. Five of the seven parties contacted by Jefferies did, however, express some degree of interest in a transaction, but noted that the timeframe was too short for a meaningful response. Shortly thereafter, the Board directed management to enter into an exclusivity agreement with Calix based on its offer of $7.72 per share. Despite Occam’s improved financial performance during the exclusivity period (which the parties subsequently extended), on September 15, 2010, the Board approved the merger with Calix for consideration then valued at $7.75 per share, consisting of a mix of 49.6% cash and 50.4% stock. The Occam stockholders approved the merger agreement, and the merger closed in February 2011.
In post-closing litigation, plaintiffs alleged that the directors and officers of Occam breached their fiduciary duties during the sale process by unreasonably favoring Calix over Adtran and by failing to develop or pursue other alternatives to the merger that could have generated higher value for Occam’s stockholders. Plaintiffs also claimed that the proxy statement contained materially misleading information regarding the sale process and projections prepared by Occam’s management during the sale process.
The Court held that the transaction was subject to the enhanced scrutiny standard of review. Applying enhanced scrutiny review on defendants’ motion for summary judgment, the Court found that the record supported the inference that the process employed by defendants fell outside the range of reasonableness by, among other things, unreasonably favoring Calix over Adtran and other potential bidders during the sale process, by giving Adtran a 24-hour ultimatum to revise an offer that was already at a premium to Calix’s best offer, and by instructing Jefferies to conduct a 24-hour market check over a holiday weekend and then not following up with third parties that expressed interest. In light of the exculpation provision in Occam’s charter that insulated the director defendants from liability for breaches of the duty of care and the Court’s determination that plaintiffs failed to establish that a majority of the directors were not independent and disinterested, the director defendants argued that they could not be found liable under enhanced scrutiny review unless their actions were motivated by bad faith. They argued that, under Lyondell, bad faith requires evidence that the director defendants had an actual intent to do harm or had consciously disregarded their obligations by utterly failing to attempt to obtain the best price reasonably available for Occam.
The Court rejected the argument that the category of bad faith conduct that was at issue in Lyondell is the only type of bad faith claim available to plaintiffs, and concluded that plaintiffs could survive summary judgment under other recognized theories of bad faith, including plaintiffs’ claim that defendants had acted in bad faith by intentionally acting with a purpose other than advancing the best interests of Occam. However, the Court concluded that the record did not support an inference that the outside directors had acted with such an improper purpose, and for that reason granted summary judgment in favor of the outside directors as to the process-based claims. The Court denied summary judgment on the process-based claims as against the officer defendants on the grounds that there was greater evidence of self-interest with respect to the officers and that the officers, when acting in such capacity, were not covered by the exculpatory provision.
The Court also declined to grant summary judgment with regard to plaintiffs’ disclosure-based claims. The Court noted that it was not clear at the summary judgment stage whether the alleged disclosure violations resulted from a breach of the duty of loyalty or the duty of care and therefore that a trial was necessary to determine whether, and to what degree, the exculpatory provision insulates the director defendants from potential liability related to such claims. The Court also noted that it could not infer that the directors acted in good faith due to evidence in the record that supported a finding that the directors knew about certain projections for the year 2012 that were not disclosed, that they were in a position to know that certain statements in the fairness opinion relating to those projections were false, and that the defendants had engaged in questionable conduct during discovery relating to the projections.